Fooled by your “friends”

Do not get too friendly with your investment adviser. It lowers your guard and increases your risk of being deceived, warn BI researchers Harald Biong and Kenneth H. Wathne.

KNOWLEDGE @ BI: Purchase of Financial Products

There are regular reports in the media about private individuals and organisations who feel they have been duped by deceitful salespersons when purchasing various types of financial products.

In many cases, the salespersons have represented reputable financial institutions. The customers often had a close and trusting relationship with a salesperson who called himself investment adviser or financial adviser.

Associate Professor Harald Biong and Professor Kenneth H. Wathne at BI Norwegian School of Management have studied this phenomenon in more detail, and looked into what happens when we feel we have been duped by our adviser ”friends”. The result of their study has been published in the Norwegian popular science magazine Magma.

Professor Kenneth H. Wathne, BI Norwegian School of Management

Complicated products

A common feature of the cases that have come to the attention of the media is that they involve products so complicated the customers found them difficult to understand. This applies both to risks and the return potential.

”The seller knows more about the qualities of the product than the buyer. In technical terms this is referred to as asymmetrical information between the seller and the buyer,” Biong and Wathne point out, both of BI Norwegian School of Management’s Marketing Department.

Not only are the products highly complex. They also have experience and/or credibility qualities which make it difficult for the buyer to assess the product qualities prior to purchase.

In some cases this can be a motivator for the seller to sell products he or she will make a profit from, but which are not necessarily the best option for the customer. In such a case, the seller acts opportunistically, i.e. he (or she) acts deceitfully vis-à-vis the customer in order to serve their own interests.

Associate Professor Harald Biong, Norwegian School of Management.

Performance-related pay results in more raw sales

Many financial institutions make use of provisions and other performance-related award schemes both at institution and individual levels. A bank will charge a certain percentage for handling a loan. Stockbrokers receive a commission in the form of a percentage of shares traded. Salespeople receive a share of the sales they generate. The more a salesperson sells, the more he will earn and the larger the employer’s turnover will be.

For services which also involve advice, such as financial products, the seller also has another employer, i.e. the customer.

The customer expects that the seller will provide advice on products that are in his or her best interest. The customer, however, is often not qualified to check whether the seller does in fact provide the right advice. 

”If this is the case, performance-related pay will increase the risk of the seller proposing solutions that are in the best interest of the seller, rather than the customer. Thus, the award system of the financial institution may promote deceitful behaviour, according to the market researchers.

In their BI Master of Science thesis (Kjenslie and Kringlebotten 2008), Celin Kjenslie and Inger Kringlebotten have examined companies’ and municipalities’ purchases of financial products.

They proved that performance-related pay for sellers of financial products increases the risk of them selling products whose promises cannot possibly be delivered and that result in more profit for the seller than the customer.  

Keep your adviser at bay

In order for financial institutions to be able to sell complicated financial products, they need to establish good and trustful relationships with their customers. This is true for both personal and corporate customers.

This is also the reason why many financial institutions invite their customers to various social and relationship-building events. Biong and Wathne urge buyers to be on their guard.

Many of the customers who feel duped seem to have developed a close and personal relationship with their financial advisor. How could this happen? Surely friends do not deceive each other?  According to Biong and Wathne, the reason can be a difference in the views and expectations of their roles.

The salesperson is first and foremost a representative of his company and his role is to sell. The customer, for his part, may see the seller as a genuine adviser and friend. This creates an imbalance in the seller/customer relationship.

The trust that the customer has in the seller can result in the customer lowering his guard and refraining from obtaining information that could correct the seller’s presentation of the positive sides of the investment.

If the seller/customer relationship becomes too close, the risk of being exposed to deceitful (opportunistic) conduct increases, Kjenslie and Kringlebotten point out in their Master of Science thesis. They find that the closer the seller/customer relationship, the more exposed the customer is to being exploited by the other party.

Avoid being duped

Biong and Wathne have prepared six practical tips for buying products or services that are difficult to assess.  This will reduce your risk of being duped by opportunistic sellers:

  1. Be aware as a customer that financial advisers are salespeople who first and foremost play the part of a business person.
  2. Be on your guard.
  3. It is important to be particularly careful of business transactions that are characterised by close personal relationships.
  4. Do not be on too close terms with the seller. It may be nice to participate at social events with the seller, but this is not necessary in order to maintaining a good business relationship.
  5. Preferably choose suppliers that you have a neutral and balanced relationship with.
  6. It may be a good idea to obtain assessments from several sources. This will help gain an overview of all aspects of the offer that you are considering.

Reference:

Biong, Harald og Wathne, Kenneth H.: Når ”vennene” lurer deg. Magma Issue No. 5-2009 (in Norwegian).

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